Further one-legged update on the reporting season

Well folks, we are at the tail end of reporting season. I don't know about you, but I will be glad to give my one leg a much needed rest after this bout of ass-kicking.

23 August 2013

LYL results out. NPAT for FY 2014 will be reduced by 50%. Price is getting interesting, but my call is that there could be slightly more pain for LYL given their position in the food-chain.

CAB analysis. Postulate that market is overweighing the impact of ACCC recommendation to reduce 10% to 5% for payment systems.  The absolute downside is that $45m being wiped from the top travels right to the bottom, reducing FCF from $60m to $15m. Multiple compression follows as ROE of 20% becomes 5%, turning a good business into a capital intensive substandard business. A compression of multiple to 8 means the current market cap of $500m falls to $120m, which is a 75% drop. It is probably obvious that the outcome lies somewhere in between the absolute downside and the current situation, therefore it will be helpful to map out multiple scenarios in preparation for a price opportunity.

26 August 2013

SCD results.  Operating cashflow of $2m, resulting in $7.2m in cash, but there is $1.2m in tax liability and $1.6m tied up with banks as security for bank guarantees.  Factory revalued downwards from $4.4m to $3.2m. Equity increased from $10.2m to $12.6m.  Service revenue increased from $4.5 to $5.2m.  Orders on hand $6.9m. One customer made up 30% of revenue. I have covered this company in a previous post.

MTU results.  Underlying margins appear to be declining.  ROA declining. Debt increased.

VTG results.

MLD results.

HSN results out.

27 August 2013

SRV results out. Operating cashflow of $27m (after paying tax of $10m). Occupancy increasing. Cash on hand $99m. Weakening AUD may boost earnings in FY14. 23 out of 38 immature floors will mature in FY14.  Opening another 8 large floors which will boost total office space by 10%.  All USA floors are cash flow neutral and all expected to mature in FY14. Occupancy rate is 88% as at June 2013 (USA recovery).  Using $27m of FCF, with 10% RRR, assuming zero growth for 10 years and adding unencumbered cash of $90m, yields $345m value.  Using dividend discount model, on grossed up dividend figures, current market cap requires dividend to rise by 5% every year, and terminal value of 10x grossed up dividend.  Current price means that an investor gets growth for free. I have held this for over 5 years now (first post here), and this long holding period has been helped immensely by a very competent management.  

FLT results out. NPAT up 20%.  Amazingly, current price implies growth of 5% per annum in FCF for the next 10 years. I missed picking this up during the GFC for under $4, which means a 10-bagger has gone down the gurgler.

VEI results out.  All metrics declined. Revenue down, gross margins down, cashflow down, but surprisingly, wage expenses and doctor payments were also down.  FCF of $18m, debt of $45m. DCF of $168m, less debt of $45m, yields $123m. 148m shares on issue.

Examples of edge- information, analysis, behavioural, structural. From Robert Robotti.

28 August 2013

TWD results out.  Good yield. Exposure to housing in SE Queensland. Worth a deeper look.

AMA results out. Revenue up, but EBIT down. EBIT margin increased by 2%.  Company is debt free, with cash at $10m in August 2013.  Cashflow very strong at $10m. 332m shares. Net of cash, AMA priced for no growth. Good to see a capable and honest CEO delivering on his promises.

IFM- founder CEO is leaving and has sold all his shares.

WTF results out.  Revenue down, profits down, and cashflow down. But somehow market is valuing shares for 10% growth pa for 10 years. Madness.

MLB results out. Heavy in cash, new management team coming in, but premium core business under pressure.  Core business valued at 5x cashflow after backing out cash chunk.

TTI results out. Debt still of concern.

29 August 2013

VOC prelim results out. Revenue increased to $66m. Profit down. Cashflow $18m, tax $3m. Free cashflow $15m.  Fibre and DC showed tremendous growth.  Cash balance of $14m will fully fund next year’s $13.3m capex. Locked in recurring cashflow will pay off IRU obligations of US$10m next year. USD hedge runs out in Dec 14, so some exposure to declining AUD. FCF $15m, current market cap implies 5% growth pa for 10 years. Adding debt to get EV of $220m, with FCF $15m, implies less than 10% growth pa.  In the presentation, VOC stated that FY14 capex is in response to customer demand, and this was repeated.

CTE Prelim report out. NPAT $1.25m. Operating cashflow $1.9m. FCF $1.6m. Cash on hand $5.7m. No dividend declared.  Wage costs up $300k and one-off capex spend.  $2m tax losses remaining.  Record number of blood cord clients. FCF estimated at $1.7m. Fair value at $23m, assuming no growth. But note:   “The Board is confident that subject to any unforeseen circumstances, the benefits of its common infrastructure and operations systems to support the business units will allow it to increase revenue, improve margins and overall financial performance of the Company during the next financial year.”

IPP HY report out.  Revenue period to period hardly moved.  Not a good sign, as M’sia went backwards due to elections, but increase in prepaid services plus record month in July, so momentum will continue. HK shows very good growth and is close to breakeven, locking in 4 out of 5 major developers.  INA growth slowing but still strong, whereas Singapore is lagging (still number 2). REA trading at 14X revenue. IPP is trading at 12x revenue.  We await next quarterly cashflow statement.

30 August 2013

DDR results out. Cashflow negative.

SST results out. Loans paid to other entities??

UOS HY results out. I have held this for over 3 years, and posted about it here. Within the HY report, I found an amazing and pristine balance sheet:

Cash	$429m
Receivables	$159m
Inventories	$294m
Land held for property development	$20m
Property plant and equipment	$28.2
Investment properties	$566.8m
Total of Asset Items above	$1497m
Financial liabilities	$319m

Rent and parking fees for half year is $20m.  Shares on issue is 1.1b, market cap is AUD$580m.  Book value increased 15% over 6 months.

That's it folks.  Time to sit back and think through ideas. By the way, the reading list has been updated, for those interested.

Disclosure:  My family and I own shares in AMA, CTE, SRV, SCD, TWD, IPP, VOC and UOS.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Pain Killers

I wish there are more blogs with articles such as this.

Disclosure: I own shares in MVP.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

UOS- keeps getting better

Mr Market is quite generous with this one.

Consider this:

1. Property developer with minimal debt;

2. Growing at 20% plus per year for the past decade;

3. Flushed with cash;

4. Rental earning properties in prime areas;

5. Huge runway;

6. Asian market exposure;

7. Buying back shares in chunks;

8. Priced at nearly half NTA;

9. MOS increasing with every decrease in AUD;

10. Steady stream of dividends;

11. Management with demonstrated capability and integrity;

12. 191% rise in NPAT in first quarter alone for major subsidiary.

In effect, a value play with free growth upside. 

Disclosure: I own shares in UOS.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

About nothing in particular

A quick note to my small band of loyal readers.

There are often periods of long silence on this blog.

The long periods in between frenetic activity could be understood if you read the start of this post.

I am not inclined to blog about nothing. There are other talented people better able to monetise a philosophy of nothing. See here. I am not quite so gifted.

On average, I get a good investable idea every three months. This could be quite unsatisfactory to people looking for ideas every week, if not every day. Nevertheless, in the context of a portfolio with about 12 to 20 positions, with average holding periods of 3 to 5 years, a good idea every 3 months is plenty enough.

Heck, this may even be too much for Warren Buffett's 20 punch card holes. At my current rate, I only have 5 years before I am stopped out.

But we do what we can, with what we are given, as best as we could.

CMI update

I purchased CMI base on the premises set out in this blog post.

On 19 February 2013, CMI's share price jumped as ASIC sold the overhang parcel for $2.65. The resulting market capitalisation of CMI reached $100m.  being what I estimated to be conservative fair value.

Consequently, I began to prepare to sell. The share price has reached a conservative fair value and more importantly, I was unwilling to stay the long haul with the current management. As I have explained previously, management competency and integrity at these relatively small companies can have a major effect on shareholder value.

On 20 February 2013, we found out that Acorn Capital has emerged with slightly less than 10% holding in CMI. I have great respect for the managers at Acorn Capital, and accordingly, I was prepared to wait until the half yearly result is published and hence deferred my sale decision.

On 27 February 2013, CMI published its half yearly results.  My overall impression was as if management has fallen asleep on the wheels. No doubt Mr Colin Ryan had other more pressing matters to attend to, notably his prosecution by authorities in New Zealand on charges of misleading conduct. Just to backtrack a little, CMI's announcements on 18 and 20 February 2013 did nothing to allay my deep mistrust of this board. If anything, my fears were actually accentuated by the contents of these announcements.

Looking at the results, accounts receivables and inventories continued to increase. CMI has enough inventories for 10 months worth of sales. This is an inefficient use of capital. The tax bill was higher due to an overprovision of $581k in the previous period which ate into cashflow. Only half of debt repaid. Electrical is still making good margins, but margins are decreasing. TJM still making losses of $600k despite a revenue increase, and taking up over $29m of assets. This division should be sold.  

What took the cake was that recently appointed director Stephen Lonie mysteriously resigned without any reason.  

On 27 and 28th Feb 2013, all CMI shares in the incubation fund was sold at $2.65. The gain is 59.6% in slightly under 3 months. Quite a fortuitous windfall considering the circumstances.

As a matter of disclosure, I still own a small holding of CMI in my family account. Unless circumstances change, this holding will also be sold if the share price approaches $2.65 again.

Obviously, this will continue to be on my watchlist. No doubt there are some lessons to be learned here, primarily as to whether assessment of management should be a strict filter, or whether this factor can be balanced off against a deeply undervalued share price.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Business going for a song (and a one-legged dance)

Imagine that you are the owner of a manufacturing business.

You manufacture leading edge scanning equipment which scans and analyses materials in realtime.  Your customers are operators of cement factories, coal mines, coal fired electricity stations and iron ore producers, and you are proud of your product because it saves costs for your customers. Moreover, it is good for the environment as your machines reduce wastage, reduces electricity usage and increases plant efficiency.

Your business has a history going back to 1981, with a founder hailing from the esteemed CSIRO.  You employ a group of dedicated engineers who has created ingenious products which have been successfully installed in over 1000 locations around the world. Your patents and intellectual property portfolio is valued at over $1m. Your business has weathered the turbulent economic climate for over 3 decades, and most recently has emerged from the GFC unscathed.  Your bank is flushed with cash of over $5.2m, and you  own your own factory valued at $4.43m, with a $2m mortgage on it. Other than that, you owe the banks nothing.

Your business has had its up and downs, but nevertheless the business has generated profits for the last 7 years, even through the trough of the GFC. You have build up net value from under $5m all the way to over $10m in 6 years, despite generously returning over $1.7m in capital to all shareholders last year. Business is good, with a backlog of orders. on the books. You will probably make about $1.5m to $2m this coming year.

One day, some hotshot investment banker walks into your factory. He takes a look around, and says that he will offer to buy your business, your factory, your IP, your management team, on a walk-in walk out basis for $8m. He figured that you have $5.2m in the bank, $4.4m worth of real estate property and a mortgage debt of $2m, which comes to roughly $7.6m, and he says you can keep the change.

Would you agree to sell? Chances are you would tell the banker to go to hell. The offer is insulting. Even if you make only $1.5 m per year after tax, you would probably be asking for $7m at least for the business on top of the cash and property values. A realistic offer to start talking would have to be in the vicinity of $15m.

For some curious reasons, even with exactly the same situation, things work slightly differently in the sharemarket.

On 11 March 2013, Mr Market is kindly offering me a slice of Scantech Limited (SCD) for 45 cents. With 17.6m shares on issue, plus about 1.7m worth of options exercisable at prices of 70 cents and above, the undiluted market capitalisation of SCD at 45 cents is $7.9m.

This is the 90 seconds pitch to buy SCD:

“As at Dec 2012, SCD has $5.2m of cash in the bank. It owns a factory valued at $4.4m, and this factory has a mortgage securing $2m. Cash and property less debt totals $7.6m. At 45 cents, SCD has a current market cap of $8m. At this price, the business is valued by the market at just $400k. The business has been profitable for the last 8 years, and generated cash of $50k and NPAT of $260k last half year. The company manufactures and supplies equipment which analyses compositions of materials in realtime on conveyor belts. The equipment is used by companies in bulk commodities such as cement, coal and minerals. The order book is increasing and stood at $9m as at Dec 2012, and importantly service revenues are starting to catch up with equipment sales. Management owns a substantial amount, and navigated the GFC without making at losses or raising any capital. In fact, they did so well that they returned $1.7m to shareholders as a capital return in 2012. Management has given guidance for a similar result in 2013 as 2012, which is about $1.7m of NPAT.”

This is the 90 second pitch against buying SCD:

“The company owns the factory and therefore does not pay rent. Let’s assume the company sold the land and leased it back at market rates. As industrial property is valued at yield, taking a conservative 8% yield on $4.4m yields a yearly rental expense of $352,000. We credit the finance costs of $130,000 per annum (since the $2m mortgage is no longer required) to yield a net expense of $222,000 impacting the bottom line. This virtually wipes out half of the half yearly profit to $150,000, and puts the company into cashflow negative for the half.  In this scenario, the company will have $7.5m of cash, and a business barely breaking even.  We should assume mining capex is decreasing going forward, and thus 2012 and 2013 will probably be peak revenue for SCD. $8m is probably a correct fair value, being $7.5m of cash with a nominal amount of $500k for the business which has historically erratic margins, net profits and cashflow.”

The critical investment issue with SCD is just simply, is the business worth more than $400,000 and if so, how much is the business worth? The problem with the negative case is that the first half is traditionally the weak half. SCD sold 11 machines, but is contracted to deliver 17 machines the next half. So we can be reasonably confident that figures for the full year will be respectable, probably above $1m in NPAT.  If we average out NPAT over the last 7 years, we get average NPAT per year of $850k per annum. A conservative 6x multiple for this equates to $5m. These are conservative, and we can easily mount an argument for the business to be valued at $8m. If this is so, addition of cash and property yields intrinsic values of $15m to $16m, double the current market cap, thus achieving a 50% margin of safety.

The downside to SCD is adequately covered by real cash and hard assets. The cashflow of SCD is also covered by an increasing stream of service fees. Service fees have increased steadily from $1.9m in 2006 to $4.5m in 2012, and the only year it has dropped is 2011 by a mere 10%. As the installed base of equipment gets larger, service fees will form an important buffer to earnings going forward. Another investor has pointed out that any decline in mining capex will not have a major impact on operating mines which will concentrate on production efficiencies, thus increasing opportunities for SCD.

Enjoy and prosper.

Disclosure: The author owns shares in SCD.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Simplicity, Consistency and Valuation

Knowledge is timeless.

This piece of lucid and erudite wisdom from 1981 by Dean Williams.

I read it when people say "this time it is different" or when I reach for spreadsheets.

Enjoy and prosper.

COF: update

Happy Chinese New Year to all!

COF published its half yearly results on 11 February 2013.  Revenues from Geosciences and International Development increased from previous half, and revenue from Project Management decreased. Margins for Geosciences decreased, margins from International Development increased, and Project Management incurred a loss. Overall, this is quite a commendable result given the difficult conditions in the last half year within the mining and mining services sector. 

I am expecting a much better result this half given the improvements in conditions. In any event, COF's financials are clearly improving since my last posting here: http://peterphan.blogspot.com.au/2012/12/coffey-international-limited.html

Cashflow looks very good. After adjusting the operating cashflow to account for movements in trade receivables, trade payables, increase in debt and increase in cash holding, the half year operating cashflow comes to about $17m.  Net debt has decreased to $61m.

Market cap has increased from $82m since last posting to about $100m on 11 February 2013. A conservative estimate of full year cashflow at $25m yields an enterprise value/cashflow ratio of 6.4. My view that a fair value ratio of 10 remains, and hence COF appears to remain good value despite a 25% increase in price.

Disclosure: The author owns shares in COF.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Xmas and New Year break

Investing does not provide much of a "break".  I am making the best of the situation, and taking a rest, so my time spent on investing is much reduced during this period.

Given the events in the US at the end of the year, the markets and the portfolios under my management have been given a fillip. Though pleasing, this means that buying opportunities are being reduced with the daily rise in prices.

I have a suspicious feeling that finding bargains may not be as easy in 2013. Nevertheless, there is no reason not to be fully prepared.

To my readers, best wishes for the coming year, and may your portfolio be headed steadily towards the top right hand corner!

Another angle on FGE plus tidbit on CMI

Clough Limited (CLO) is another mining services company listed on the ASX and exposed to the oil and gas sector. On 11 December 2012, CLO announced that it had renewed a $200m debt facility.  How is this relevant to FGE?

CLO is the biggest shareholder of FGE, holding roughly 36% of shares in FGE.  As at June 2012, CLO had $146m cash on its balance sheet. The last substantial shareholder notice published by FGE in May 2012 showed that CLO added a further 3% in compliance with the creep provisions of the Corporations Act. 

In 2012, CLO made $42m in profits and is currently trading at PE 15. FGE has $130m cash as at June 2012, and has had a good half with NPBT forecasted at $50m. If CLO takes $100m of its cash, combined with $130m of FGE cash, totalling $230m, it could afford to take over FGE for up to $360m. The current market cap for FGE is $335m. Alternatively, CLO could just use $200m from its debt facility to do the same thing, and after the takeover, repay the debt in full with FGE’s cash plus a bit of its own. With CLO’s huge blocking and controlling stake, a rival bidder is very unlikely.

An acquisition by CLO will be immediately and significantly PE accretive without any synergistic costs savings. In fact, CLO’s earnings would more than double, and its margins will increase by about 50% with FGE in its fold, and this can be done with minimal dilution.

All these are pretty obvious, so what am I missing?

My best guess from CLO’s perspective is that there is no hurry since CLO has a large blocking stake which renders the possibility of a rival bidder vanishingly small. CLO can take advantage of lower prices using the creep provisions. In the current environment for mining services, it is also prudent for CLO to preserve its cash rather than making any bold moves. CLO’s largest South African shareholder is probably loath to risk contributing more capital to CLO and prefers CLO to keep a clean healthy balance sheet.

A takeover by CLO has been long anticipated and speculated by the market, at much higher prices for FGE than the present.  These speculations have intensified with recent management changes at FGE, and the recent exercise of options by outgoing management at prices up to $5.60 perhaps indicate that they do not see any potential upside beyond $5.60 for FGE due to the potential for a takeover at prices below that.

It will be interesting days ahead for FGE.

Lastly, a little tidbit on CMI, with the newest director, Stephen Lonie, spending over $120,000 of his own money buying up 65000 shares in recent days.

Disclosure: The author owns shares in FGE and CMI.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Forge Limited (FGE)

I recently tweeted that I am examining 3 shares which I believe are undervalued.

The third of these is Forge Limited (FGE), and I am forced to publish this earlier than expected as the company has jumped the gun on me (explanation below).

An extreme valuation sometimes makes purchase decisions very easy. The investor is given such a large margin of safety in relation to the purchase price such that not many things need to go right to get a decent return. On 5 December 2012, FGE provided this opportunity when it released an earnings update for FY13. 

FGE told the market that it expected to make Net Profit Before Tax of $90m to $100m for FY13. Give that 5 months of FY13 have already elapsed, and given that FGE stated that it expected the NPBT to be split evenly between two halves, at least $40m of NPBT has already been earned.

By way of background, FGE is an engineering and construction company providing mining services to the mining industry in Australia and Africa. As a group, mining services companies on the ASX have been deserted en masse by investors fearing the end of the commodities boom and a contraction in mining investments.

In the words of Jamie Mai, extracted from the book Hedge Fund Market Wizards by Jack Schwager, “markets tend to overdiscount the uncertainty related to identified risks.” Further, “although markets are generally good at estimating the magnitude of a contingent liability, they are often poor at evaluating outcomes probabilistically.”

It is my view that in the case of FGE, the market has overdiscounted both the rate and the magnitude of future earnings decline.

Valuation

FGE has 87 m shares on issue.  At AUD$3.85 cents, market cap is AUD$335m.  

Earnings

Earnings update on 5 December 2012- NPBT$100m. NPAT $70m. At least $40m of NPBT has already been made to date.  Backing out cash of $130m on the balance sheet (as at June 2012), this is effectively PE 3. An investor is paying about $210m for all future cashflows from FGE, bearing in mind that as at June 2012, FGE had an order book of $900m, and since June 2012, FGE has announced further contract wins totalling $360m.

A good part of FGE fortunes are tied to the actions of RIO, FMG and Roy Hill. These companies are racing against time to expand their iron ore output before iron ore prices decline further. 

Going through the financial statements, variable costs made up 60% of revenue in 2012, up from 46% in 2011. However, wage costs as a percentage of revenue have declined from 37% in 2011 to 27% in 2012.  This lower level of fixed costs provides a safety buffer in the event of a contraction in revenues.  At current prices, even if FGE's earnings declined by 50% (which is quite a distinct possibility), earnings multiple are still in the lowish single digits.

The market is pricing FGE as if it will experience an earnings decline to the vicinity of $20m per annum.  This is not impossible, but for what it is worth, I believe that the chances of this happening in the next 5 years is quite remote. The more likely scenario is that within the next 5 years, total free cashflow from FGE will exceed the share price being paid today.

Disclosure: The author owns shares in FGE.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Coffey International Limited

I recently tweeted that I am examining 3 shares which I believe are undervalued.

The second of these is Coffey International Limited (COF).

COF is an engineering consultancy company with a history going back to 1959. It listed on the ASX in 1990. The company went on a diworsefication spree from 2003 to 2008, acquiring more than 30 businesses from a combination of cashflow, capital raisings and debt, until the GFC stopped this stupidity. Faced with heavy losses from write-offs, coupled with heavy staff turnover, management changed hands in March 2011. Since then, current management has restructured the business by selling and discontinuing non profitable businesses, cutting down debt, and improving operational efficiencies. 

In a nutshell, the core businesses of COF are quite stable.  This arises from its entrenched relationships, embedded expertise and geographical reach, aided by a very fragmented customer base. Not unlike the story of GEICO, management is engaging in cancer surgery, stripping away the useless parts and retaining the good businesses at its core.  Management’s efforts are starting to gain traction- costs are coming down, margins are being maintained or improved, staff turnover is reduced.

Due to disappointing results in the last few years, and an anticipated slowdown in mining investments, I believe that the market is now overdiscounting near term uncertainties for COF, and overlooking the underlying trend improvements in COF’s businesses.

Valuation

COF has 256 m shares on issue.  At AUD$0.32 cents, market cap is AUD$82m.   Operating cashflow is AUD$21m per annum, giving P/Cashflow multiple of 4.  If I add $66m of net debt, the enterprise value/ cashflow multiple is 7. Given COF’s long operating history and stability of its revenues, a reasonable valuation is about 10 times multiple.  Hence current market price is a 30% discount, assuming no costs improvements and no revenue or margin growth.  Recent update by management on 4 December 2012 appears to indicate that revenues are holding whilst costs are still being removed, although the outlook for the second half is still uncertain.

Earnings

Trailing PE is 11 based on NPAT of $7m derived by adding back $37m worth of write-offs.  At this stage, due to write-offs and restructuring, earnings multiple is not a reliable indicator of the value for COF.  In the long run, we expect the earnings to match the cashflow, which will bring earnings multiple into the low single digit figures. 

Balance Sheet

As at June 2012, COF has net debt of $66m.  There are $9m in franking credits.  

Disclosure: The author owns shares in COF.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

CMI Limited

I recently tweeted that I am examining 3 shares which I believe are undervalued.

The first of these is CMI Limited.

CMI operates two divisions, Electricals and TJM. 

Electricals revenue for FY 12 is $74m, returning EBIT of $21.5m.  TJM revenue for FY 12 is $40m, but EBIT is only $1m.

Electricals are facing headwinds due to declining coal sector investments in Qld, and also subdued industrial and housing activity.  

TJM has a lot of room to improve when performance is compared with ECB and ARP.  TJM is an established high quality brand with steady revenue, however the division is saddled with high costs due to the number of distribution centres, and management appears to be trying to contain costs by moving manufacturing to China.  ECB and ARP both generated EBIT margins in the mid teens, and if TJM can do just 10% EBIT, the EBIT from this division will go up 4x. I suspect that the TJM division is being dressed up for an eventual sale, and logical acquirers are AMA and ARP.

The problem with CMI has been management’s treatment of minorities over the last several years, culminating in litigation brought by Troy Harry last FY. With the death of long time owner Catalan, and succession to his daughter Leanne Catalan, the situation with management is still less than optimal, especially as management owns a controlling stake.  We suspect management’s actions account for the perennial share price underperformance, made worse by the previous unwieldy structure of having two classes of shares.  The structure has since been rationalised this FY following litigation brought by minority shareholders.  There is still some overhang of a big parcel of shares bought by Leanne allegedly in contravention of the provisions of the Corporations Act which was the subject of litigation at the Takeover Panel.  This matter is still subject to appeal, although I believe this is unlikely to matter in the big scheme of things.

Valuation

CMI has 38.2m shares on issue.  At AUD$1.70 cents, market cap is AUD$58m.   Operating cashflow is AUD$9.5m, giving P/Cashflow multiple of 6, and the multiple is slightly less than 7 if we include debt of about $8m.  Normalised EBIT is about $20m. A very conservative 5x EBIT puts CMI at AUD$100m. Current AUD$58 implies a 42% discount to a very conservative valuation. Even if EBIT drops by half to $10m, the EBIT multiple of 6 is still within conservative territory.

Earnings

Trailing PE (normalised without write-off based on NPAT of $14m) is 4.   Outlook given on 30 November 2012 appears to indicate that Electricals is holding and TJM is improving.  Market cap of AUD$58m allows an earnings deterioration by 50% to $7m,  and even then, the PE is still a lowly 8.  This provides a degree of margin of safety

Balance Sheet

As at June 2012, CMI has $8m in bank debt.  This is more than covered by operating cashflow of $9m. There are $16m in franking credits. There is also an impairment provision for a third party loan of $17m which has been written off to zero, but which I am confident will result in some recovery. There is a personal guarantee for $2.5m for this loan which CMI is now pursuing.  Working capital is about $37m which is about 1/3 of sales, and I expect there is some room for improvement here to boost the balance sheet.

Disclosure: The author owns shares in CMI.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Seeking Patience

 "All man's miseries derive from not being able to sit quietly in a room alone.”   Pascal, Blaise

Patience is a great asset, and I believe, a major differentiator of performance between fund managers.  Every one of us are blessed (or cursed, depending on your viewpoint) with different abilities. It is a simple logical inference that the more actions we take, the more mistakes we are likely to make. This is an undeniable fact in the highly probabilistic world of business and investing.

Once again, patience is a simple concept in theory, but very difficult in practice. As some pundits say, even inaction is an action by itself. Stock prices can meander for years before a sudden spurt brings prices back to fair value.  The time period for such spurts varies between 2% to 9% of the total holding period. So in a holding period of say 5 years, the share price performance comes in a period lasting only 1.2 to 5.4 months. In the meantime, glamour stocks are flying, and other opportunities appears to be zipping by while your own stocks do nothing. A similar situation arises when we attempt to resist the temptation to sell stocks which have increased in price. Let your winners run, they say. It is not an easy task to maintain equanimity and objectivity in such situations. 

Needless to say, this week has been quite trying on my patience.

22 October 2012

Listening to TGA presentation. TEF aiming for $50m critical mass, funded by debt. Both TEF and Cashfirst to start major contributions in 2014 and 2015. One person kiosks reminds me of Bank Rakyat.  Pretty significant competitive advantage once fully rolled out. NCML getting some major exposure to QBE, CBA and SDRO.  Rentals maintaining excellent performance and spitting back cash to fund other lines.  I can easily envisage a situation within 3 to 5 years when TEF, Cashfirst and NCML collectively contributes as much as Rentals, and a doubling of EPS.

23 October 2012

Rereading Competition Demystified by Greenwald.

UOA DEV Q3 results out. Total assets increased by 13.5% to MYR$2430m.  Total liabilities increased by 21% to MYR$357m. Total equity increased by 12.3% to MYR$2072m.  MYR$88m NPAT for quarter. 4 quarters=MYR$300m-$360m. UOS 66% share is MYR$200-$240m=AUD$60m to $80m. On a lowly PE 8 range, UOS should have a valuation range of AUD$480m to AUD$640m, and this ignores rental from investment properties held at parent level. A second way to value is taking UOADB’s market cap of MYR$2.1b, of which 66% is MYR$1.4b=AUD$460m, which ignores UOA REIT and also all assets held at parent company level. Every which way I cut it, there is a significant undervaluation. A slap in the face type of undervaluation.

Assessing CAB- bearing in mind that the market usually overdiscounts near term uncertainties. AGM on Wednesday 28 November 2012.

26 October 2012

IPP still headed the right way. http://blog.iproperty.com.my/ceo-blog/the-iproperty-group-is-gaining-weight/  Cannot wait for this baby to turn cashflow positive.

IPP extended leadership in HK- arguably the most important of all its markets. Waiting for news that the other 3 property developers have joined the party, and it will all be game over for the competitors. HK will make more money than Malaysia, Indonesia and Singapore combined. IPP revenue running at AUD$15m per annum now.  Compared to REA in 2003 with AUD$9m revenue.  In 2004 REA revenue jumped to AUD$19m, and it started making a profit.  REA revenue is AUD$280m in 2012 with penetration of 60% of RE spend. IPP  currently at 5% penetration of RE spend. A six-fold increase to 30% RE spend will online will see revenue at AUD$90m.  Current market cap for IPP is AUD$160m.

27 October 2012

CSL- profit guidance up 20% despite currency headwinds. This is a sad miss for an entry price below $30 in February 2012. The opportunity cost is a whopping 66% gain forgone, not counting dividends.

AMA- CEO address. Appears to be squeezing out growth and good performance from all divisions, especially FluidDrive with quarterly EBIT up a stunning 200% pcp.

Disclosure: The author owns shares in AMA, IPP, UOS and TGA.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Activity Update

Mulling over my activity over the last 7 days since my last blog post, I am reminded of John Arnold’s famous quote:

“War is sometimes described as long periods of boredom punctuated by short moments of excitement. History is often similar, if rather safer.”

I would tentatively venture that investing is similar.  After all, history is a record of the endeavours of humankind. Business is but one small facet of these endeavours. Logically, the same process should apply. My investing is characterised by a never-ending search for ideas, many of which are discarded.  Looking back over my notes, good ideas that are investable are rare, about one every 3 months where I am concerned.

Here is a summary of what I have been up to over the last 7 days, gleaned from my journal.

14 November 2012

Thinking about businesses with longevity, a long compounding trajectory. Growth rates should be moderate, should not be rapidly changing.  Compounding machines.  Need to learn more about financial history, especially businesses that have been around and unchanged for a long time.  Very few businesses can stand the ravages of time and competition.  Banking and law are two examples. BHP is another. Needless to say, adaptability is crucial.

Continued going through list of shares.

15 November 2012

ABS data shows MV vehicle sales for Oct down 2.8% from Sept, and SUV down 3%. Data conflicts with FCAI figures published at the start of the month.  Investigated cause for difference.

Continued going through list of shares.

16 November 2012

Looking closely at CMI Ltd. TJM has a good brand, but management is stuffing up via wrong business model. Electricals facing some serious headwinds.

19 November 2012

Boom in shale gas- LNG transport- shipping.

Finished treasure hunt project for industrials.

20 November 2012

TGA results out- NCML continues to drag- lesson= large acquisitions seldom work. Cashflow strong. Rentals steady. Arrears/impairments down. Cashfirst and TEF looking promising. TEF being funded entirely by debt.  Market did not like result. Dividend lifted. No long term reason to sell but unsure of whether to add more.

FFI- catching up with news. Chairman's presentation and latest leasing deal are positive news as value is unlocked from the land parcel.  Attempting to do a revised valuation.

21 November 2012

Considering the implications of the US becoming energy independent, and the many projects in the pipeline for LNG.  A long tailwind. Thinking of industries that will benefit from declining input costs of LNG. There are 4 obvious candidates on the ASX that my non-creative mind can think of.

LYL management gave an unusual downward guidance over next 2 years.  Mining services slowing down rapidly. Hats off to a management with impeccable integrity.

Disclaimer: the content of this post is not to be relied on as financial advice.  It contains my personal opinion only, plus facts that I cannot verify to be accurate.  Do your own research and seek financial advice where appropriate. I have made many mistakes in the past, and will continue to do so in the future.

Back After Lengthy Hiatus

It has been nearly 3 years and 2 months after my last post. I wished I could say in that time, I have returned a market-stomping 25% per annum compounding on my portfolio. Alas, it is not to be.

Rather, what had happened was as follows:

In year 2008- X capital allocated to shares.

In year 2009- X capital became 1/2 X- you read that right. The portfolio declined by 50%.

In year 2010- portfolio recovered to 0.8 X.

In year 2011- portfolio recovered fully to X. A further 1.5X capital injected, thus portfolio totalled 2.5X.

In year 2012- portfolio of 2.5X gained 60%. Portfolio now 4X.

In hindsight, the mistake was simple. I did not buy when others were fearful. The most glaring example seared in my memory is FLT at $5.50, after Skroo Turner bought heavily at $3.50. This would have been a five-bagger in 3 years, not counting dividends.

The consolation is that it has not been time wasted. I have come to appreciate the huge importance of having a disciplined process. The resurrection of this blog is intended to ensure I keep to my process, and to share with readers the daily trials and tribulations of a value investor. Hopefully, we will all learn something in the process.